A Search Model of Unemployment and Inflation*

This paper introduces money into the standard labor‐matching model. A double‐coincidence problem makes money necessary as a medium of exchange. In the long run, a rise in the growth rate of money leads to higher inflation and higher unemployment, such that the long‐run Phillips curve is not vertical. The optimal monetary growth rate decreases with greater worker bargaining power, the level of unemployment benefits, and the payroll tax rate.     

Inflation and Unemployment in General Equilibrium*

When labor is indivisible, there exist efficient outcomes with some agents randomly unemployed, as in Rogerson (1988) . We integrate this idea into the modern theory of monetary exchange, where some trade occurs in centralized markets and some in decentralized markets, as in Lagos and Wright (2005) . This delivers a general equilibrium model of unemployment and money, with explicit microeconomic foundations. We show that the implied relation between inflation and unemployment can be positive or negative, depending on simple preference conditions. Our Phillips curve provides a long‐run, exploitable, trade‐off for monetary policy; it turns out, however, that the optimal policy is the Friedman rule.     

THE EVOLUTION OF INFLATION AND UNEMPLOYMENT: EXPLAINING THE ROARING NINETIES

This paper analyses the relation between US inflation and unemployment from the perspective of ‘frictional growth,’ a phenomenon arising from the interplay between growth and frictions. In particular, we focus on the interaction between money growth and nominal frictions. In this context we show that monetary policy has not only persistent, but permanent real effects, giving rise to a long‐run inflation‐unemployment tradeoff. We evaluate this tradeoff empirically and assess the impact of productivity, money growth, budget deficit, and trade deficit on the US unemployment and inflation trajectories during the nineties.     

Vacancies, unemployment, and the Phillips curve

The canonical new Keynesian Phillips curve has become a standard component of models designed for monetary policy analysis. However, in the basic new Keynesian model, there is no unemployment, all variation in labor input occurs along the intensive hours margin, and the driving variable for inflation depends on workers’ marginal rates of substitution between leisure and consumption. In this paper, we incorporate a theory of unemployment into the new Keynesian theory of inflation and empirically test its implications for inflation dynamics. We show how a traditional Phillips curve linking inflation and unemployment can be derived and how the elasticity of inflation with respect to unemployment depends on structural characteristics of the labor market such as the matching technology that pairs vacancies with unemployed workers. We estimate on US data the Phillips curve generated by the model. While we can reject the baseline new Keynesian Phillips curve in favor of the search-frictions specification, we show it is still too stylized to fully describe the dynamics of firms’ marginal costs.     

Low‐inflation Targeting and Long‐run Unemployment*

The model of Akerlof, Dickens and Perry (2000) (ADP) predicts that low inflation may cause unemployment to persist at high levels. When applied to U.S. data, their results strongly rejected the conventional NAIRU model. We apply the ADP model to Swedish data. The fact that our Swedish data also reject the NAIRU model has a number of interesting implications for the Swedish economy and, potentially, for other European countries as well. The results indicate that raising the Swedish inflation target from 2 to 4 percent would bring long‐run unemployment down by several percentage points. The possibility of ADP‐type long‐run Phillips curves also across the euro countries may raise some concern about the EMU project. While detailed studies on other countries are needed, there is nothing to suggest that these non‐vertical Phillips curves would not differ considerably across the euro countries. Any single inflation level targeted by the ECB would then generate excess unemployment in individual member states.     

Phillips curve in US: New insights in time and frequency

The paper explores the co-movement between unemployment and inflation rates in US by using a battery of wavelet tools. The dataset covers the period 1945Q1–2017Q4, having quarterly frequency.The main findings reveal a not stable Phillips curve in US, depending on economic context, seasonality and time-persistence. The Phillips curve is not validated during economic turbulences, while it works over expansion economic periods. Even so, the trade-off between unemployment and inflation is unstable under seasonal growth components and time-persistence, running from short- to medium-term. No link between unemployment and inflation is found in the long-term.     

HYSTERESIS AND THE NAIRU IN THE EURO AREA

This paper analyses the Nairu in the Euro Area and the influence that hysteresis had on its development. Using the Kalman‐filter technique we find that the Nairu has varied considerably since the early 1970s. The Kalman‐filter technique is applied here using explicit exogenous variables. In order to test for hysteresis, the dependence of the Nairu on actual unemployment and long‐term unemployment is estimated and found to be significant for the Euro Area and Germany, respectively. The existence of hysteresis effects implies the possibility of a long‐run non‐superneutrality of monetary policy.     

Why Has Australian Wages Growth Been So Low? A Phillips Curve Perspective

Wages growth in Australia has recently been the lowest in two decades. One possible explanation is a decline in the non‐accelerating inflation rate of unemployment (NAIRU). We examine this hypothesis by estimating a wage Phillips curve including a time‐varying NAIRU. Our findings are: (i) the NAIRU has recently been around 5.5 per cent; (ii) our approach increases the precision of the NAIRU estimates; (iii) low inflation expectations have been an important contributing factor; and (iv) the long‐run annual wages growth is nearly 3 per cent. We also find that the underutilisation rate suggests greater slack exists, but is less useful in explaining wage developments.     

Does money have a role in the inflation process? Evidence from Australia

Inflation, defined as a sustained increase in the price level, is considered a monetary phenomenon, as it can be explained within the framework of money‐demand and money‐supply relationships. In the extant literature, money growth is shown to remain causally related to inflation across countries and over time, irrespective of the exchange rate regime and stability of the money‐demand function. Nevertheless, emerging literature suggests a diminishing role of money in the conduct of monetary policy for price stability, especially under inflation targeting. Monetary policy in Australia under inflation targeting since 1993 is an example of policy that denies a relationship between money growth and inflation. The proposition that money does not matter insofar as inflation is concerned seems odd in both theory and the best‐practice monetary policy for price stability. This paper uses annual data for the period 1970–2017 and quarterly data for the period 1970Q1–2015Q1. It deploys both the Johansen cointegration approach and the autoregressive distributed lag (ARDL) cointegration approach to investigate for Australia whether money, real output, prices and the exchange rate (non‐stationary variables) maintain the long‐run price‐level relationship that the classical monetary theory suggests in the presence of such stationary variables as the domestic and foreign interest rates. As expected, the empirical findings for Australia are consistent with the classical long‐run price‐level relationship between money, real output, prices and the exchange rate. The error‐correction model of inflation confirms the presence of a cointegral relationship among these variables; it also provides strong evidence of a short‐run causal relationship between money supply growth and inflation. On the basis of a priori theoretical predictions and empirical findings, the paper draws the conclusion that the monetary aggregate and its growth rate matter insofar as inflation is concerned, irrespective of the strategy of monetary policy for price stability.     

The phillips curve and US macroeconomic performance during the 1990s

This paper identifies two competing accounts of recent US macroeconomic performance, both of which are capable of explaining the concurrence of low unemployment and low inflation experienced by the US after 1995. Econometric evidence provides partial support for both views, establishing that while there has been no change in the position of the long run Phillips curve in the US during the 1990s, this long run Phillips curve is likely not vertical. These results suggest that recent US macroeconomic performance is not sustainable and that US policy makers ultimately face a choice between higher unemployment or higher inflation in the long run.     

On Persistent Demand Shortages: A Behavioural Approach

We incorporate two sets of behavioural assumptions, fairness concerns and insatiable desire for money, into a dynamic optimization model to illuminate how they can generate persistent aggregate demand shortages. We obtain the conditions for persistent unemployment and temporary unemployment. Policy implications differ significantly between the two cases. A monetary expansion raises private consumption under temporary unemployment but not under persistent unemployment. A fiscal expansion may or may not increase short‐run private consumption but crowds out long‐run consumption under temporary unemployment. Under persistent unemployment, however, a fiscal expansion always increases private consumption. The “paradoxes of toil and flexibility” also appear.     

Prospects for inflation in a high pressure economy: Is the Phillips curve dead or is it just hibernating?

As the US labor market has tightened beyond full employment with relatively little evidence of inflation pressure, observers are increasingly inclined to declare the demise of the Phillips curve, that is, the flattening of its slope to zero. This paper reviews a substantial range of empirical evidence on this point, by assessing the performance of the conventional expectations-augmented Phillips curve for both prices and wages, based on both historical macro or national level data and panel data for states and MSAs (cities). National data going back to the 1950s and 60s yield strong evidence of negative slopes and significant nonlinearity in those slopes, with slopes much steeper in tight labor markets than in easy labor markets. This evidence of both slope and nonlinearity weakens dramatically based on macro data since the 1980s for the price Phillips curve, but not the wage Phillips curve. However, the endogeneity of monetary policy and the lack of variation of the unemployment gap, which has few episodes of being substantially below zero in this sample period, makes the price Phillips curve estimates from this period less reliable. At the same time, state level and MSA level data since the 1980s yield significant evidence of both negative slope and nonlinearity in the Phillips curve. The difference between national and city/state results in recent decades can be explained by the success that monetary policy has had in quelling inflation and anchoring inflation expectations since the 1980s. We also review the experience of the 1960s, the last time inflation expectations became unanchored, and observe both parallels and differences with today. Our analysis suggests that reports of the death of the Phillips curve may be greatly exaggerated.     

Verification of the natural unemployment rate hypothesis in the South African economy

The results obtained confirming the natural unemployment rate hypothesis, i.e., that in the long run there is no trade-off between inflation and unemployment. The results also support the weak rational expectations hypothesis, that with the increase in the information the economic agent will eliminate the money illusion, though the process towards the final elimination of the money illusion is very long, and therefore short-term Phillips curve can be sustained for quite long periods.     

Policy implications of a non-linear Phillips curve in a stochastic environment

When the Phillips curve is non-linear, fluctuations of the unemployment rate below the mean will have a larger impact on the inflation rate than fluctuations above the mean. This paper shows that this causes conventional measures of the “natural unemployment rate” to underestimate the mean unemployment rate consistent with stable inflation in the long run. More importantly, it reveals a potential long-run trade-off between unemployment and economic stability.     

Unemployment–inflation trade-offs in OECD countries

Inflation and unemployment reduce welfare of individuals and should be as low as possible in any economy. Cointegration and Granger causality tests suggest that there are long run relations between these two variables among the OECD economies. While rates of unemployment vary significantly among these economies, rates of inflation have stabilised at lower rates as a result of inflation targeting policies adopted in them during the last two decades. The Phillips curve phenomena are still empirically significant for 28 out of 35 of these OECD economies in country specific regressions; in fixed and random effect panel data models and in a panel VAR model for 1990:1 to 2014:4. Country specific supply curves and Okun curves are consistent to thin Phillips curve relations. Leftward shifts in the Beveridge and Phillips curves require labour market reforms balancing between job creations and destructions. Complementing macro stimulations by microeconomic structural and institutional reforms can bring efficiency in bargaining for wages and employment among firms and workers to make unemployment–inflation trade-offs more significant and relevant in these economies.     

The hump-shaped behavior of inflation and a dynamic externality

We propose a general equilibrium model that explains the empirical evidence of the hump-shaped response of inflation to a monetary policy shock. The model replaces backward-looking indexation à la Christiano et al. [2005. Nominal rigidities and the dynamic effect of a shock to monetary policy. Journal of Political Economy 113(1), 1-45] with a dynamic externality into the production function of firms. The model, armed with sticky wages and variable capital utilization, has two offsetting effects on real marginal cost over the business cycle. First, increasing factor prices raise real marginal cost in response to an expansionary monetary policy shock in the intermediate run. Second, a dynamic externality reduces real marginal cost in the short run because it raises productivity in response to an increase in output following the shock. Overall, the resulting short-run decrease and intermediate-run increase in marginal cost replicate the hump-shaped behavior of inflation under purely forward-looking price and wage Phillips curves.     

Is Globalization Weakening the Inflation–Output Relationship?

This paper investigates whether trade and financial openness has weakened the inflation–output trade‐off and caused a shift in the preferences of monetary authorities. Based on the backward‐looking Phillips curve and a Taylor‐type interest rate rule, our results for France, the UK and the USA for the 1970–2012 period do not provide support for the relevance of globalization in making inflation less responsive to output expansions. Moreover, the change of preferences of Central Banks towards growth‐oriented objectives is neither due to higher trade nor to financial globalization.     

DID TIME INCONSISTENCY CONTRIBUTE TO THE GREAT INFLATION? EVIDENCE FROM THE FOMC TRANSCRIPTS

We use evidence from detailed records of FOMC deliberations to argue that time inconsistency theory can help explain the excessive monetary expansion that characterized Arthur Burns's tenure as Federal Reserve Chairman (1970–1978). The records suggest that the Fed perceived a Phillips curve tradeoff and political pressures that made it difficult to adopt disinflationary policies; the tendency toward excessively expansionary policy was exacerbated by the short-run planning horizon the Committee faced in each of its meetings. We argue that comparative static predictions of the time inconsistency model are consistent with the rise of inflation during the Burns years and its subsequent fall.     

The optimal neglect of inflation: An alternative interpretation of UK monetary policy during the “Great Moderation”

This paper argues that UK monetary policymakers did not respond to the inflation rate during most of the “Great Moderation” that ran from the early 1990s to the mid-2000s. We derive a generalisation of the New Keynesian Phillips curve in which inflation is a non-linear function of the output gap and show that the optimal response of the policy rule to inflation depends on the slope of the Phillips curve; if this is flat, manipulation of aggregate demand through monetary policy does not affect inflation and so policymakers cannot affect inflation. We estimate the monetary policy rules implied by a variety of alternative Phillips curves; our preferred model is based on a Phillips curve that is flat when output is close to equilibrium. We find that policy rates do not respond to inflation when the output gap is small, a situation that characterised most of the “Great Moderation” period.     

Estimating Europe’s natural rates

This article estimates potential output, the natural rate of unemployment, and the core inflation rate using aggregated euro area data. The empirical model consists of a Phillips curve linking inflation to unemployment. An Okun-type relationship is used to link the output gap to cyclical unemployment. The model further accounts for new developments in unobserved component models by allowing (i) for correlation between shocks to the natural rates and the corresponding gaps and (ii) structural breaks in the drift of potential output and the natural rate of unemployment.